What Small Business Owners Need to Know About Income Tax Instalments

Transitioning from being a full time employee to small business ownership or self employment means that you need to cultivate self discipline.  You can no longer rely on your employer to take care of business functions that do not relate to your job ,and must take a much more active role in ensuring that you remain on top of your obligations whether it is collecting payments from customers, paying bills or ensuring that you do not run afoul of Revenue Canada.  One of these obligations requires that you pay your own income taxes, which you are required to pay when you file your income tax return. Additionally, once you exceed a certain income threshold you are also required to pay income tax and sales tax instalments.

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What is an Instalment Payment?

When you are an employee, your employer is responsible for deducting and remitting deductions from your paycheque to the revenue agencies.  Small business owners, who are unincorporated such as sole proprietorships, are required to take on this responsibility themselves.  Since unincorporated small businesses are only taxed on the profits of the business which are inconsistent from month to month, it can be difficult to estimate taxes payable (unless of course you have an excellent accounting system and even then you still have to estimate your income and deductions from other sources ).  As such Revenue Canada requires that you pay “instalments” of taxes payable based on an estimate.

What are the different types of Instalment Payments?

Unincorporated small business owners are require to make periodic payments towards:

• Income taxes

• GST/HST and QST if applicable

How are instalments calculated?

Given that it is very difficult to estimate your income taxes precisely until you actually prepare your tax return, there are different methods by which you can pay instalments.  The first method is to base payments on your prior year taxes payable.  For example, if you owed $10,000 in income taxes for 2019, you would be required to pay $2,500 per quarter in 2020.  This gets a little more complicated as, since you don’t know your income taxes payable until later in the year, the first two instalments due March 15th and June 15th are based on your 2018 income.

Alternatively, given the fluctuations between profit earned in one year vs. another, you can estimate your taxes for the current year and remit based on these amounts.  For example, if your average tax rate was 35% in 2019 and you estimate that after expenses you will earn $75,000 in the current year, you can remit $26,250 over four instalments equaling $6,562.  Note that if you think that your profit will be higher or lower, your tax bracket might change thereby resulting in a different average tax rate. I recommend that business owners use a tax calculator to get an idea of their taxes payable.

GST/HST and QST quarterly instalments are simply calculated at 1/4th of the amount you paid in the previous year (based on your annual filing amounts)

What are Instalment Due Dates?

If you are a sole proprietorship/unincorporated business, your instalment due dates are as follows:

• Income tax instalments: March 15th, June 15th, September 15th and December 15th

• GST/HST and QST Instalments: April 30th, July 31st, October 31st and January 31st.

What happens if you don’t make instalments?

Revenue Canada charges interest on unpaid instalments at prescribed rates which are currently around 5%.

Revenue Quebec similarly charges interest at the normal published rate as long as Instalment payments exceed 75% of the amount payable.  If your instalment payment is less than 75% of the payment required, interest of 10% per year, capitalized daily, is applicable. 

What else do you need to know about instalments?

• You are not required to pay instalments in your first year of business as there is no history upon which to make the calculation.

• Revenue Canada does not require you to pay instalments if your taxes payable are estimated to be $3,000 or less.  If you live in Quebec, this amount is reduced to $1,800.

• Quebeckers similarly have to pay instalments if estimated taxes payable to Revenue Quebec are $1,800 or less.

• You are only required to make GST/HST and QST instalments if the amount payable for GST/HST and QST for the year each exceeds $3,000.  In this case, payments must be made within one month of the fiscal quarter.

• Both Revenue Canada and Revenue Quebec will send you a notice once they have assessed your prior year tax return informing you of the amount payable along with a remittance slip.  Payment can be made via cheque or online banking. They do not however inform you of the amount payable for GST/HST and QST which you have to calculate on your own.

By remitting instalments on a timely basis you reduce the amount of potential interest costs (which are also not tax deductible to your business) and more importantly reduce the temptation to spend money that you will ultimately have to pay to CRA which can result in costly and unpleasant debt. 
Looking for a better understanding of your small business taxes? Check out our comprehensive guide to understanding and preparing your small business tax return or set up a consultation.